Stock funds and ETFs worth leaving home for in 2014

Recovering international markets can boost your investment portfolio

SAN FRANCISCO (MarketWatch) — Some of last year’s best investments are poised for another year of impressive performance, and to participate you just have to broaden your horizon.

Stock markets in the world’s developed regions were standouts in 2013, despite alarming headlines and repeated head-fakes that rattled mutual fund and exchange-traded fund investors. But when you tune out the noise, the signs are evident that the euro zone’s most economically troubled countries are emerging from recession, while Japan, though also challenging for investors, is embarking on a path out of deflation.

The average diversified international stock fund gained almost 21% in 2013, helped by a 6% advance in the fourth quarter, according to preliminary data from investment researcher Morningstar Inc. A typical international ETF rose 20%

Results were even better for Japan-focused stock mutual funds, soaring 27% on average, and Europe stock funds, which advanced 26.5%. Meanwhile, world stock funds, which can also invest in the U.S., gained 25% — a strong showing that reflected the S&P 500’s
SPX, +0.01%
32.4% total return for the year.

Submerged markets

But international-stock investors lost big in the emerging markets. Once-highly touted Brazil, India, China and Russia — the BRICs — broke down in 2013. Emerging markets stock funds finished the year up 0.5%, saved by a 3.2% fourth-quarter gain, while comparable ETFs lost 1% for the year.

The bloodshed last year was worst for funds focused on Latin America, including Brazil, which fell 12% on average, while India-focused funds lost 11%. China region funds, while positive for the year with an 11% gain, lagged behind developed markets and revealed the extent of investors’ concern about China’s slowing economic growth rate and Beijing’s nascent efforts to reform and streamline the country’s business practices.

Accordingly, such glaring underperformance only makes some investment pros more interested in scouting emerging markets for bargains.

“Emerging markets have gone out of style,” says David Winters, manager of the Wintergreen Fund
WGRNX, +0.73%
which gained 17% in 2013. “But the long-term reality is that the U.S. and western Europe are mature, highly leveraged economies without a lot of growth. Emerging markets are parts of the world where there’s higher growth and a lot of potential.”

Investors should realize, however, that emerging markets do not trade in lock step. The Federal Reserve’s plan to taper support for the U.S. economy, along with continued stabilization of the euro-zone economies, is bound to siphon foreign capital from emerging markets as that money returns to more confident home markets.

“You have to be very specific about what you buy,” says David Semple, manager of Van Eck Emerging Markets Fund
GBFAX, -0.47%
which gained 11% in 2013. But for emerging markets as whole, he adds, “It’s hard to see much momentum.”

With that in mind, Semple and other investment managers are bullish about China — “new” change-minded China, that is, a country addressing domestic and demographic obstacles, versus the “old” China that was built on the strength of state-owned industry and exports.

“China looks interesting and promising,” says Rudolph-Riad Younes, who runs RSQ International Equity Fund
RSQVX, -0.73%
with Richard Pell. “On a multiple basis it looks cheap, and the government seems intent on doing the right thing. It pays to be there, but you have to be very vigilant.”

“There is something significant under way,” adds Michael Kass, manager of Baron International Fund,
BINIX, -0.47%
up 22% in 2013. ‘That is the type of reform we want to invest in.”

Developed case

Reforms in another part of Asia are already delivering results to investors. In Japan, Prime Minister Shinzo Abe’s government, along with the Bank of Japan, is fighting Japan’s long war with inflation using new tactics — collectively known as “Abenomics” — aimed at getting Japanese to spend and to invest in stocks and other income-producing assets.

One caveat about investing in Japan is that Abenomics weakens the yen, which means that gains from Japanese stocks are worth less in U.S. dollars. The opposite is true when the yen strengthens versus the dollar. If you believe the yen will continue to weaker, then consider exchange-traded funds and mutual funds that carry no currency risk, such as WisdomTree Japan Hedged Equity Fund
DXJ, +0.62%
which gained 41.5% in 2013. WisdomTree last year introduced WisdomTree Japan Hedged SmallCap Equity Fund
DXJS, +0.92%
which focuses on smaller Japanese companies.

MarketWatch Special Report: Investing in 2014 »

The euro zone’s recovery is giving investors reason to be more than tourists. The European Central Bank is keeping interest rates low, and ECB President Mario Draghi’s pronouncement in July 2012 to “do whatever it takes” to maintain the euro zone seems to have been a psychological, if not actual, catalyst.

More investment pros, defying the skeptics, expect to be pleasantly surprised by their European holiday. “People are missing out on a big opportunity,” says Winters, the Wintergreen manager.

“Germany and Northern Europe are strong and stable,” adds Clem Miller, an investment strategist at Wilmington Trust Investment Advisors. He adds that Italy and Spain, while clearly more volatile than other parts of Europe, offer the prospect of strong 2014 returns given improvement in those countries’ real estate and banking sectors.

European companies today are recovering in similar fashion to their U.S. peers, says Jonathan Ingram, a manager of the JPMorgan Intrepid European Fund
VEUAX, -0.79%
Euro-zone businesses are regaining competitiveness, he notes, adding that Europe’s domestic companies in particular will see better-than-expected top-line growth in the coming year,

John Bilton, European chief investment strategist at Bank of America Merrill Lynch, concurred. In a recent research report, he wrote that reflation of the euro-zone economies will be the central theme for this year, he adds, with European stock indexes having the potential for a 9% to 12% gain. Said Bilton: “A longer and more sustainable rally will play out in 2014.”

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